Germany’s Changing Financing Landscape

A couple of weeks ago, Deutsche Pfandbriefbank (“pbb”) issued a press release on its 2012 results stating an increase in its loan volume in 2012 to €5.6 billion, comprised mostly of commercial real estate. At first these numbers seemed misleading and against everything else we are reading and empirically observing about a decrease in lending volumes and more difficult financing conditions in Germany. A recent Schroders Property survey substantiated this and Morgan Stanley’s “blue paper” published in November 2012 further described Germany’s banking industry as carrying a de-leveraging risk of €100-175 billion!

Sure, loan volume to commercial real estate lending seems to be up for pbb but we believe this statistic includes some of the bigger residential portfolio transactions from last year. Furthermore, new business volume increases by pbb may stem from taking a large market share due to a decrease in the number of players overall. Foreign banks have all but exited the German commerical real estate market after incurring huge losses on overpriced portfolios bought during the 2004-2007 peak and some domestic players have closed shop altogether. Indeed, the Pfandbrief, which is essentially a covered bond (the pre-cursor to the securitization market) is the most relevant funding instrument for German mortgage banks, but as a highly regulated instrument, these banks focus on loans below a 60% loan-to-value (LTV), which is in line with pbb’s press release reporting an increasein volume, but a decrease in average LTV’s from 65% in 2011 to 56% in 2012.

So what do fewer players, less competition and lower LTVs mean for borrowers? It means lower levels of financing at higher margins on more select projects. One German mortgage bank recently reported it had achieved margins of 280 bps for new business compared with 120 bps pre-crisis. Of course, as long as the ECB continues to support the banks with virtually free financing, financing costs for borrowers will remain low, but the unknown is how long these interest rates will remain depressed. In the meantime, margins will continue to widen for banks and borrowers will continue to struggle getting their projects financed as lending criteria becomes more stringent.

Fortunately at Activum, we believe in the motto, “leverage is the result of success, not a tool to generate success.” This is how it should be. Too many borrowers and lenders have gone out of business in the last ten years from taking on too much leverage on inferior assets to finance deals from the outset. Leverage should be a way to boost returns and not to make or break a strategy. At Activum we invest in high quality underlying real estate with high occupancy potential that will achieve profitability regardless of the amount of leverage used. This thinking gives us the confidence to buy buildings on an all-cash basis, using leverage only once the asset is fully stabilized. On the flipside, it also enables us to stay flexible with our strategy. As long as the underlying asset is strong, it doesn’t matter along which part of the capital stack we invest – investments can range from debt all the way to equity. Ultimately, this gives us access to a significant opportunity – filling the ever growing funding gap, which the new banking landscape marked by lower LTVs and more restrictive borrowing requirements have created.